Friday, May 13, 2005

Mortgage REIT: Acceptable Risks "Do Not Exist"

Dynex Capital is a mortgage REIT. Going through this weeks press release produced these comments by Thomas B. Akin, Chairman of the Board of Directors.

" With respect to reinvestment strategies for our capital, our viewpoint remains the same, that acceptable risk-adjusted returns do not exist in mortgage assets today, and we will continue only to invest in high-credit quality, very short-duration assets. We are focused, however, on our longer-term investment strategies, avoid putting our balance sheet at undue risk in what likely will be a volatile environment over the next twelve months."

That is what Fannie Mae is saying in it's corporate communications. The firm recently sold off it's investment in another mortgage REIT, Bimini Mortgage Management as well as the manufactured housing segment.


At 5:17 PM, Anonymous Don said...

Chart for DX is a real eye opener for RE longs:

It can happen to you!

At 5:34 PM, Anonymous bigdog said...

I have to give DX credit for being honest about the current mortgage environment. Its stock has made a big comeback from death (25 cents) to over 7 bucks.

That said, it's a tiny company and I don't know why anyone would buy stock of a mortgage co that doesn't pay a dividend. I'll pass. But kudos to the CEO for his honesty.

At 7:17 PM, Anonymous Anonymous said...

This is beyond my comprehension. Probably because I am not into stocks, just residential real estate. Don and Bigdog's posts would be even better if they explained what all this meant. For example, I looked at the DX link and could not determine anything useful from it. Thanks.

At 8:02 PM, Anonymous Don said...

Hey Anon,

Here's a link with more info, followed by my analysis:

First off, let's see what they do:

"The Company is a financial services company which invests in a portfolio of securities and investments backed principally by single family mortgage loans, commercial mortgage loans and manufactured housing installment loans."

Ok, these guys invest in mortgages backed by real estate. About as solid as you can get if you think 'real estate always goes up'. How do they do it?

"The Company funds its investment portfolio with both borrowings and funds raised from the issuance of equity."

So they borrow money short term and lend it long term at higher rates. Now, let's get to the meat of what's wrong:

"During 1999, as a result of the difficult market environment for specialty finance companies such as the Company [deletia] This difficult market environment was a result of the disruption in the fixed income markets during the fourth quarter of 1998. As a result of such disruption, investors in fixed income securities generally demanded higher yields in order to purchase securities issued by such specialty finance companies."

Ok, so basically, liquidity collapsed and they had to pay out the wazzo for funding to carry their portfolio. Now normally this wouldn't be a problem, but here's the smoking gun:

"As more fully described in Note 1 in the accompanying consolidated financial statements, the Company is currently subject to certain significant risks and uncertainties, including violations of covenants in credit facilities, litigation, and the lack of access to new sources of capital."

Note the phrase 'violation of covenants in credit facilities' Basically, they hit a trigger. People who don't follow corporate finance generally think that loans to companies are like loans to people. They aren't. They often contain clauses that, if violated, cause the note to become payable immediately. To put this in personal terms it's like having a mortgage that comes due immediately if you lose your job.

So, how does this affect the RE market? Well, as far as I can tell, a big part of why long term rates are as low as they are is due to companies carrying long term debt using short term funding, which is exactly what these guys were doing. That's fine in moderation, but when everyone's doing it, it's a ticking time bomb. Where do you lay off the risk to? If something similar happens, and it might not take something as big as the Russian bond default of 98 to do it this time, the vicious circle unleashed by spreads increasing will force long term rates higher much faster than they would have risen if the spreads hadn't compressed and had risen as the fed funds rate rose.

At 8:10 PM, Anonymous powerpuffgirl said...

Doug Nolan's on fire tonight:

"And lower mortgage rates and higher home prices might very well sustain the Credit Bubble blow off for a little while longer. Yet prolonging the Mortgage Finance Bubble is terrible news. Nothing imparts greater distortions or liquidity dependency upon the Economic Sphere than mortgage excesses. And, in the end, it is the risk of today and tomorrow’s home loans (inflated prices, stretched buyers, and ill-conceived mortgage terms) that will prove the most damaging to the system. All eyes on mortgage spreads. The Mortgage Credit Bubble makes the GM risk Bubble look awfully teeny-weeny."

At 9:18 PM, Blogger John Law said...

wow, I can't believe a mortgage lender said that.

At 12:44 AM, Anonymous forensics said...

The CEO may have stated the obvious but more likely is in CYA mode. Must be bad news ahead for the firm so the CEO is preparing the soil so investors (if there are any left) aren't overly surprised by it.

At 2:38 AM, Anonymous Anonymous said...

Hedge fund failures are signs of impending macro-economic distress. They usually happen when there is a sharp change of conditions and their financial "risk-management" models begin to fall apart.

At 6:55 AM, Anonymous Anonymous said...

This thread has been very informative to me. Thank you all.


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